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Published: 26 May 2006 Russia's Natural Resources Ministry is reportedly considering lowering the bar for oil and gas fields to be designated "strategic" which - along with the Ministry's support for Russian companies gaining a controlling stake in key Sakhalin Island projects – could further limit foreign participation in Russia's oil and gas industry.

Global Insight Perspective

Significance

Russian business daily Vedomosti reported that President Vladimir Putin has told the government to lower the threshold for oil and gas deposits to be determined "strategic" under draft legislation, a move which will further restrict foreign energy companies' access to Russian oil and gas projects.

Implications

Along with the Natural Resources Ministry's stated support of a study suggesting Russia raise the stakes of Russian companies in two key Sakhalin Island projects, the potential amendments to the long-awaited subsoil legislation reflect the growing resource in the Russian oil and gas industry.

Outlook

Although the government has not explicitly stated that it will seek to revise existing Sakhalin contracts, the reports are another sign that Russian government's stated commitment to court foreign investment is at best half-hearted and – at worse – an outright dishonest.

Mixed Messages No More?

For the past three years, there has been a healthy amount of scepticism on the part of Western oil companies when Russian President Vladimir Putin has stated his commitment to attracting foreign investment. Ever since BP's landmark investment in TNK, there have been numerous indications that the Kremlin (Russia's presidential administration) is only lukewarm, if that, in its desire to see continued foreign investment in Russia's oil and gas industry. For every ConocoPhillips acquisition of a minority stake in LUKoil, there has been a corresponding Marathon exit from Russia, a cancellation of ExxonMobil's Sakhalin-3 contract, and a new office created to monitor field licence agreements - to say nothing of the devastating effects of the "Yukos affair" on the psyche of foreign energy companies (see Global Insight's special report, The Turn of the Russian Oil Industry).

Hence, the report in Vedomosti yesterday that President Putin has requested that the Natural Resources Ministry lower the bar on energy and mineral deposits to be considered "strategic", thereby limiting foreign investment, is right in line with the trend toward resource nationalism in Russia. Whereas the Ministry had previously sought to clarify that only fields with 1 billion barrels of oil reserves or 1 Tcm of gas reserves would be classified as strategic - and thus only majority Russian-owned companies could operate those fields under draft subsoil legislation - the new report suggests that the threshold would be lowered to just 50 million tonnes (366,500 barrels) and 500 Bcm of gas. Instead of only a handful of fields falling under the strategic designation, as the Ministry had previously stipulated, the net effect of the proposed changes to the legislation would potentially restrict hundreds of Russian hydrocarbon deposits to operatorship by Russian majority-owned companies.

Loud and Clear

If the message of this change isn't enough to deter foreign investors from wanting to participate in the development of Russia's bountiful oil and gas reserves (after all, the government has insisted that foreign companies are still more than welcome to join these strategic projects as minority investors…at least for now), then the reports of potential revisions to two key Sakhalin Island projects might just do the trick. A study conducted by the Russian Academy of Natural Science and endorsed by the Natural Resources Ministry suggested that Russia would be better off if Russian companies held a controlling stake in these projects.

The projects in question, the ExxonMobil-led Sakhalin-1 and the Shell-led Sakhalin-2 projects, came in for heavy criticism by scientists in the Academy's report, which argued that delays and cost overruns in these projects were hampering their "efficiency". "The Academy suggests boosting the presence of Russian companies in these consortia to 51% as one of the measures to boost efficiency of these production-sharing agreements [PSAs]," the Natural Resources Ministry said in a statement. Although the Ministry itself said it had no official position on the revision of the Sakhalin contracts, Reuters quoted Ministry spokesman Rinat Gizatulin as saying, "This is not the ministry's official position, but there is common sense in what scientists are saying." Moreover, Dow Jones quoted the Ministry's press secretary Yevgeny Snegirev as saying, "We support raising the stake of Russian companies in the Sakhalin projects."

The Kremlin has not backed the statements - whether "official" or not - of the Natural Resources Ministry, but neither has Putin's administration shied away from those comments. Neither Shell, which has a 55% stake in Sakhalin-2, nor ExxonMobil, which has a 30% stake in Sakhalin-1, had any comment on the matter, but the firms should clearly be worried. The two projects, which along with Total's troubled Kharyaga project make up the three PSAs still in effect in Russia, have run into problems with start-up delays, environmental issues, and rising costs, but a government move to revise an existing contract would be a major no-no to the IOCs. Following the government's earlier decision to cancel ExxonMobil's rights to the Sakhalin-3 project, another effort to dislodge the world's largest publicly-traded energy company (or even to tip the scales in favour of Russia's own Rosneft and Gazprom) at the project would certainly be met by strong resistance from ExxonMobil.

Outlook and Implications

The growing resource nationalism in Russia echoes a trend that is growing in strength around the globe as historically high oil and gas prices instill in major oil- and gas-producing countries the belief that the host government should be getting an even larger slice of the revenues from the development of their hydrocarbons. The empowerment of Rosneft and Gazprom over the past year has, in turn, fostered a belief within the Kremlin that these state-owned giants can - and perhaps should - take the place of foreign investors in developing Russia's largest oil and gas projects. The decision to lower the threshold to designate a hydrocarbon deposit as strategic is clearly being driven by the desire of Rosneft and Gazprom to expand their operations and secure even greater control of the country's all-important oil and gas industry.

While the government could be floating these new restrictions as "trial balloons" or as leverage to ensure that Gazprom (which has an un-consummated deal with Shell to gain a 25%-plus-one blocking stake in Sakhalin-2) secures its stake in Sakhalin-2, the fact remains that the Kremlin is clearly moving towards a more nationalistic policy on oil and gas, regardless of what it says about being open to foreign investment. Rosneft has a 20% stake in Sakhalin-1 via its subsidiaries, but the company appears to be angling to displace ExxonMobil as operator. The fallacy of either Rosneft, which still carries billions of dollars in debt, or Gazprom, which has no significant LNG expertise, replacing ExxonMobil and Shell, respectively, in charge of these projects at this juncture, when both projects are already well under way, is almost too ludicrous to consider - were it not evident that the Russian government is itself mulling the issue.

The worst possible scenario for IOCs is a move by the government not only to revise the Sakhalin contracts and lower the bar on the "strategic" field designation, but a potential campaign after the subsoil legislation is passed that would see the government seek to re-designate existing licensed projects as strategic, thereby replacing IOCs with Russian majority-owned companies as operator. Such a move would see the foreign-operated Samotlor (TNK-BP), Salym (Shell), and Kharyaga (Total) fields, among others, replaced by Russian majority-owned companies. While the government previously said it would not seek to impose the new legislation on existing projects expost facto, it should not be forgotten that the Natural Resources Ministry also previously said that only a "handful" of projects would be designated strategic.

Although the die has not yet been cast, the mould is clearly under construction as Russia gravitates ever closer to nationalising its hydrocarbon industry. At best, the Kremlin is sending out mixed messages by paying lip service to attracting foreign investment on the one hand, while seeking to restrict opportunities for IOCs on the other. At worst, the government is merely looking for IOCs to invest in the start-up of major oil and gas projects, then boot them out and replace them with majority Russian-owned companies when the project nears fruition.

Related Articles

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